1. automobiles and designer clothes are sure to benefit
Investment Management from the increased purchasing power of emerging
”An investment in knowledge always pays the best economies, but everyday luxuries such as cell phones
interest” Benjamin Franklin and brand name food products are becoming popular
Mutual Funds much more quickly. For example, the number of
A mutual fund is a type of Investment Company that wireless subscribers in India grew at a compound
pools money from many investors and invests the annual growth rate of 91% from 2000 to 2005, and
money in stocks, bonds, money-market instruments, Coca-Cola Company (KO) predicts that the BRIC
other securities, or even cash. countries will account for 41% of the company's growth
For example: You invest $1,000 in a mutual fund with by 2008.
an NAV (Net Asset Value) of $10.00. You will therefore Required Rate of Return
own 100 shares of the fund. If the NAV drops to $9.00 1. The minimum rate of return that an investment must
(because the value of the fund's portfolio has dropped), provide or must be expected to provide in order to
you will still own 100 shares, but your investment is justify its acquisition. For example, an investor who can
now worth $900.00. If the NAV goes up to $11.00, your earn an annual return of 11% on certificates of deposit
investment is worth $1,100. (This example assumes no may set a required rate of return of 15% on a more risky
sales charge.) stock investment before considering a shift of funds
Emerging markets are nations with social or business into stock. An investment's required return is a function
activity in the process of rapid growth and of the returns available on other investments and of the
industrialization. Currently, there are 28 emerging risk level inherent in a particular investment.
markets in the world, with the economies of China and 2. The minimum rate of return required by an investor,
India considered to be the largest.[1] According to The a stipulation that limits the types of investments the
Economist many people find the term outdated, but no investor can undertake. For example, a person with a
new term has yet to gain much traction.[2] required rate of return of 15% would generally have to
The ASEAN–China Free Trade Area, launched on January invest in relatively risky securities.
1, 2010, is the largest regional emerging market in the Required Rate of Return
world. In securities, the minimum acceptable rate of return at
The term Emerging markets is used by investment a given level of risk. Different investors have different
analysts to categorize countries that are in a transitional reasons for choosing their required returns. Normally, it
phase between developing countries that are just is determined by a person's or institution's cost of
beginning to industrialize and countries that are fully capital. For example, an investor may also carry a debt
developed. The main significance of the use of the term with a high interest rate; if an investment does not
is that investments in emerging markets are assumed to meet a required rate of return, it would make more
carry greater risk and offer less safety in investment. sense for the investor to pay down his/her debt. The
The term is often used interchangeably with developing required return is also related to the amount of risk an
markets, though this is somewhat inaccurate. Examples investor is willing to accept. One with a portfolio
of emerging markets include the BRIC countries (Brazil, consisting largely of bonds will generally have a lower
Russia, India, and China), several Southeast Asian required return than one whose portfolio contains
countries, Eastern Europe, and parts of Africa and Latin mainly stocks
America. For example, if a person buys a stock, that person may
Emerging markets are characterized by strong economic desire a required rate of return of 10% per year. The
growth, resulting in an often marked rise in GDP and investor's reasoning is that if he or she does not receive
disposable income. As a result, people in emerging 10% return, he or she would be better off paying down
countries are often able to buy goods and services that an outstanding mortgage on which he or she is paying
they previously would not have been able to afford. 10% interest.
This provides international companies with the First, a quick review: the required rate of return is
opportunity to tap large, new customer bases, defined as the return, expressed as a percentage, that
potentially driving significant growth for a number of an investor needs to receive on an investment in order
companies and industries. Though disposable incomes to purchase an underlying security. For example, if an
in emerging markets are rising, many of their citizens investor is looking for a return of 7% on an investment,
are still relatively poor. Luxury goods such as high-end
2. then she would be willing to invest in, say, a T-bill that ABC Foreign Cars is purchasing 3 German cars for its
pays a 7% return or higher. showroom floor. ABC cannot pay for the cars in in
But what happens when an investor's required rate of advance and has not yet established a credit record
return increases, such as from 7% to 9%? The investor with the German manufacturer.
will no longer be willing to invest in a T-bill with a return On the other hand, ABC has an excellent credit record
of 7% and will have to invest in something else, like with its bank. ABC goes to its bank and fills out the
a bond with a return of 9%. But in terms of the dividend documents required for a draft to be made out to the
discount model (also known as the Gordon growth German manufacturer. The payment date of the draft
model), what does the required rate of return do to the is one week after receipt of the 3 cars, giving ABC time
price of a security? to perform a thorough inspection of the delivery.
Banker's Acceptance ABC's bank knows from experience that ABC is good for
The Truth: the money (or perhaps the funds are deposited in the
In general, an acceptance is a promise to pay. bank's escrow). Therefore, ABC's bank accepts the draft
The promise is made by the person or entity that will on behalf of ABC and sends it on to the German
actually make the payment - the promissory - to the manufacturer who is now assured that he will be paid
person or entity who will receive payment - the payee, for the shipment of cars.
or beneficiary. (see PROMISSORY NOTE) IMPORTER > IMPORTER'S BANK > ACCEPTANCE >
The promise-to-pay document is called a MANUFACTURER
draft. Payment of the draft will be made on a specified Zero coupon bond
future date, so the draft is called a time draft. To seal From Wikipedia, the free encyclopedia
the promise, the promissory signs the draft and stamps A zero-coupon bond (also called a discount bond or
or writes the word "Accepted" above his signature and deep discount bond) is a bond bought at a price lower
adds the date on which he will pay the amount written than its face value, with the face value repaid at the
on the draft. time of maturity.[1] It does not make periodic interest
The draft has now been formally accepted by the payments, or have so-called "coupons," hence the term
promissory, and the commitment to pay the beneficiary zero-coupon bond. Investors earn return from the
on the due date has become a legal obligation. compounded interest all paid at maturity plus the
If the acceptor is a bank, the acceptance is called a difference between the discounted price of the bond
Banker's Acceptance. and its par (or redemption) value. Examples of zero-
A bank may accept a draft on behalf of either one of its coupon bonds include U.S. Treasury bills, U.S. savings
customers or a note holder (payee). In either case, the bonds, long-term zero-coupon bonds,[1] and any type of
promissory then becomes obligated to pay the bank the coupon bond that has been stripped of its coupons.
amount financed in full with interest on or before the A zero-coupon bond is a bond that does not pay
maturity date, and the bank becomes the primary entity interest but instead is sold at a discount, i.e., for less
obligated to pay the amount due to the payee. than its face value. For example, a zero-coupon bond
Banker's acceptances used in international trade fall with a face value of $5,000 may sell for only $4,200.
under the regulations for a DOCUMENTARY CREDIT. When the zero-coupon bond matures years later, the
For the most part, banker's acceptances are used in the bond buyer receives the full $5,000; the $800 difference
trade of goods. An example would be when a German is the "interest" earned on the zero-coupon bond. A
manufacturer needs to be paid by an American well-known example of a zero-coupon bond is the series
importer (or when an American manufacturer needs to EE savings bond sold by the U.S. Treasury. This bond
be paid by an American retailer). sells for half its face value, which ranges as high as
The retailer or importer's bank, under certain financial $10,000. One advantage to issuing a zero-coupon bond
conditions between the bank and its customer, accepts is that the issuer does not need to make periodic
to pay for the goods. Essentially, the bank is interest payments to its bondholders. One possible
substituting its creditworthiness for that of its customer disadvantage to bond investors is that zero-coupon
in order to assure the manufacturer that he will not be bond prices are more volatile on the secondary bond
hung out to dry after shipping the goods. The market, since the lack of periodic interest payments is
acceptance is then sent to the manufacturer. viewed as risky. A zero-coupon bond is also known as an
Example: accrual bond.
3. Stock Split investors, the shares are too expensive to buy in round
Definition lots.
An increase in the number of outstanding shares of a
company's stock, such that proportionate equity of For example, if a XYZ Corp.'s shares were worth $1,000
each shareholder remains the same. This requires each, investors would need to purchase $100,000 in
approval from the board of directors and shareholders. order to own 100 shares. If each share was worth $10,
A corporation whose stock is performing well may investors would only need to pay $1,000 to own 100
choose to split its shares, distributing additional shares shares.
to existing shareholders. The most common stock split Example: You own 150 shares of ABC with a basis of $24 per
is two-for-one, in which each share becomes two share, and another 100 shares of ABC with a basis of $28 per
shares. The price per share immediately adjusts to share. The stock splits 2-for-1. After the split, you own 300
reflect the stock split, since buyers and sellers of the shares with a basis of $12 per share, and 200 shares with a
basis of $14 per share. (This is true even if you receive a
stock all know about the stock split (in this example, the
single certificate representing your 250 new shares.)
share price would be cut in half). Some companies
Stock dividend
decide to split their stock if the price of the stock rises
Definition
significantly and is perceived to be too expensive for
A dividend paid as additional shares of stock rather than
small investors to afford. also called split.
as cash. If dividends paid are in the form of cash, those
A stock split occurs when a company releases additional
dividends are taxable. When a company issues a stock
stock in a structured manner without decreasing
dividend, rather than cash, there usually are not tax
shareholder equity. For example, in a 2 for 1 stock split,
consequences until the shares are sold.
an investor who owns 100 shares of a stock valued at
When you receive additional shares as a result of a non-
$100 per share before the stock split will own 200
taxable stock dividend or split, your total basis in your
shares valued at $50 per share after the split. After the
stock remains the same. The basis is divided among the
stock split the investor owns twice as many shares, with
shares you already owned and the new shares in
each share worth exactly half as much as before the
proportion to the value of the shares. In the usual case,
stock split. While a 2 for 1 stock split is probably the
where the new shares are exactly the same as the old
most common form of stock split it is not the only form.
ones, the value is the same, and basis is allocated
3 for 1 stock splits and other ratios of stock splits are
equally to each share.
also possible. In the majority of cases the purpose of a
Example: You own 400 shares of XYZ with a basis of $33
stock split is to reduce the share price of a stock in
per share (total basis of $13,200). XYZ declares a 10%
order to make the stock more affordable to a wider
stock dividend. You receive 40 additional shares and
pool of investors.
now own a total of 440 shares. Your total basis is
Stock Split
unchanged, so your basis per share is now $13,200
What Does Stock Split Mean?
divided by 440, or $30.
A corporate action in which a company's existing shares
Stock or scrip dividends are those paid out in the form
are divided into multiple shares. Although the number
of additional stock shares of the issuing corporation, or
of shares outstanding increases by a specific multiple,
another corporation (such as its subsidiary corporation).
the total dollar value of the shares remains the same
They are usually issued in proportion to shares owned
compared to pre-split amounts, because no real value
(for example, for every 100 shares of stock owned, a 5%
has been added as a result of the split.
stock dividend will yield 5 extra shares). If the payment
involves the issue of new shares, it is similar to a stock
In the U.K., a stock split is referred to as a "scrip issue",
split in that it increases the total number of shares
"bonus issue", "capitalization issue" or "free issue".
while lowering the price of each share without changing
Investopedia explains Stock Split
the market capitalization, or total value, of the shares
For example, in a 2-for-1 split, each stockholder
held
receives an additional share for each share he or she
holds.
A treasury bill, or t-bill, is a short term investment with
maturity dates ranging from four to 52 weeks. These
One reason as to why stock splits are performed is that
investments are often considered quite safe because
a company's share price has grown so high that to many
they are backed by the United States government. A
4. treasury bill differs from other types of investments in What Does Marketable Securities Mean?
that they do not pay interest in the traditional way. Very liquid securities that can be converted into cash
When an investor wishes to purchase a treasury bill, quickly at a reasonable price.
they buy buy it at a discount rate. The amount paid for Marketable securities are very liquid as they tend to
the treasury bill varies, and is decided by a bidding have maturities of less than one year. Furthermore, the
process. Once the treasury bill is purchased, the owner rate at which these securities can be bought or sold has
does not receive any money until the t-bill matures at little effect on their prices.
which time he or she will receive the face value of the t- Investopedia explains Marketable Securities
bill. This difference, the discount rate and the face value Examples of marketable securities include commercial
rate, is said to be the "interest" of a t-bill. Another paper, banker's acceptances, Treasury bills and other
benefit of the t-bill, is that when you purchase one, you money market instruments.
know exactly how much you will earn over the life of Treasury Bill - T-Bill
the investment. What Does Treasury Bill - T-Bill Mean?
Call Provision A short-term debt obligation backed by the U.S.
Definition government with a maturity of less than one year. T-
Clause in a debt instrument (such as a bond) which bills are sold in denominations of $1,000 up to a
allows its issuer to redeem it before its maturity date, maximum purchase of $5 million and commonly have
usually on one or more call dates specified in its maturities of one month (four weeks), three months (13
indenture. Also called redemption provision. weeks) or six months (26 weeks).
Call Provision T-bills are issued through a competitive bidding process
The stipulation in most bond indentures that permits at a discount from par, which means that rather than
the issuer to repurchase securities at a fixed price or at paying fixed interest payments like conventional bonds,
a series of prices before maturity. This provision the appreciation of the bond provides the return to the
operates to the detriment of investors because calls on holder.
high-interest bonds usually occur during periods of Investopedia explains Treasury Bill - T-Bill
reduced interest rates. Thus, an investor whose bond is For example, let's say you buy a 13-week T-bill priced at
called must find another investment, often one that $9,800. Essentially, the U.S. government (and its nearly
provides a lower return. Certain preferred stock issues bulletproof credit rating) writes you an IOU for $10,000
are also subject to call. Also called call feature. See also that it agrees to pay back in three months. You will not
make-whole call provision. receive regular payments as you would with a coupon
bond, for example. Instead, the appreciation - and,
Non-Marketable Security
therefore, the value to you - comes from the
What Does Non-Marketable Security Mean?
difference between the discounted value you originally
Any type of security that is difficult to buy or a sell
paid and the amount you receive back ($10,000). In this
because it does not trade on a normal market or
case, the T-bill pays a 2.04% interest rate ($200/$9,800
exchange. These types of securities trade over the
= 2.04%) over a three-month period.
counter (OTC) or in a private transaction. Finding a
party with which to transact business is often difficult;
Underwriter Meaning and Definition
in some cases, these securities can't be resold due to
1. a banker who deals chiefly in underwriting new
regulations surrounding the security.
securities [syn: investment banker]
Investopedia explains Non-Marketable Security
2. an agent who sells insurance [syn: insurance
Some examples of non-marketable securities are
broker, insurance agent, general agent]
savings bonds, series (A, B, EE, etc.) bonds and private
3. a financial institution that sells insurance [syn:
shares. The U.S. government offers both marketable
insurance company, insurance firm, insurer,
and non-marketable securities to the public.
insurance underwriter}]
Marketable securities, such as treasury bills and bonds
Underwriting refers to the process that a large financial
can be purchased and resold to the public. But non-
service provider (bank, insurer, investment house) uses
marketable securities, such as savings bonds must be
to assess the eligibility of a customer to receive their
held by the holder until maturity and can't be resold to
products (equity capital, insurance, mortgage, or
another party.
credit). The name derives from the Lloyd's of London
Marketable Securities
5. insurance market. Financial bankers, who would accept investor will call upon the margin account to
some of the risk on a given venture (historically a sea purchase investments, then repay the amount
voyage with associated risks of shipwreck) in exchange borrowed using the returns generated by that
for a premium, would literally write their names under investment.
the risk information that was written on a Lloyd's slip The primary market is that part of the capital markets
created for this purpose. that deals with the issuance of new securities.
Once the underwriting agreement is struck, the Companies, governments or public sector institutions
underwriter bears the risk of being able to sell the can obtain funding through the sale of a new stock or
underlying securities, and the cost of holding them on bond issue. This is typically done through a syndicate of
its books until such time in the future that they may be securities dealers. The process of selling new issues to
favorably sold. investors is called underwriting. In the case of a new
Private placement occurs when a company makes an stock issue, this sale is an initial public offering (IPO).
offering of securities not to the public, but directly to an Dealers earn a commission that is built into the price of
individual or a small group of investors. Such offerings the security offering, though it can be found in the
do not need to be registered with the Securities and prospectus. Primary markets creates long term
Exchange Commission (SEC) and are exempt from the instruments through which corporate entities borrow
usual reporting requirements. Private placements are from capital market.
generally considered a cost-effective way for small Features of primary markets are:
businesses to raise capital without "going public" This is the market for new long term equity capital.
through an initial public offering (IPO). The primary market is the market where the
securities are sold for the first time. Therefore it is
Margin Call also called the new issue market (NIM).
In a primary issue, the securities are issued by the
Margin calls are simply a part of buying on
company directly to investors.
margin, and while some people choose to keep
The company receives the money and issues new
their invested equity well above the minimum security certificates to the investors.
margin requirements to avoid a margin call, Primary issues are used by companies for the
others keep themselves continuously invested at purpose of setting up new business or for expanding
exactly the minimum, prompting a margin call or modernizing the existing business.
every time the market takes a downturn. The primary market performs the crucial function of
This means that as the value of someone's facilitating capital formation in the economy.
securities falls, he or she may get a “margin call” The new issue market does not include certain other
from a broker, with the broker requesting more sources of new long term external finance, such as
money to cover the maintenance margin. If an loans from financial institutions. Borrowers in the
new issue market may be raising capital for
investor fails to respond to a margin call, the
converting private capital into public capital; this is
broker can choose to liquidate his or her
known as "going public."
securities to address the problem. The financial assets sold can only be redeemed by
Margin Account the original holder.
A margin account is necessary when selling The secondary market, also known as the
stocks short, and is usually used by people who aftermarket, is the financial market where
simply want to leverage their investment, rather previously issued securities and financial
than people who can’t afford the full purchase instruments such as stock, bonds, options, and
price of the securities. A broker who offers futures are bought and sold.[1]. The term
margin accounts will charge interest for the "secondary market" is also used to refer to the
right to borrow the money, although the market for any used goods or assets, or an
interest rate is usually very low. alternative use for an existing product or asset
Brokerages set the credit limit for a margin where the customer base is the second market
account based on the credit-worthiness of the (for example, corn has been traditionally used
investor, often taking into account such factors primarily for food production and feedstock, but
as the value of assets owned and the general a "second" or "third" market has developed for
credit rating of that investor. Typically, the use in ethanol production). Another commonly
6. referred to usage of secondary market term is to securities. Sometimes referred to as a special cash
refer to loans which are sold by a mortgage bank account, these cash only investment accounts are often
to investors such as Fannie Mae and Freddie utilized for both retirement nest eggs and trusts for
Mac. minor children.
A cash account is an excellent option when the goal is to
With primary issuances of securities or financial
establish a secure nest egg for retirement. Perhaps the
instruments, or the primary market, investors
best example of a cash account for this purpose is the
purchase these securities directly from issuers
Individual Retirement Account. An IRA is completely
such as corporations issuing shares in an IPO or funded with cash deposits that are then invested on the
private placement, or directly from the federal part of the broker. Generally, the investments that are
government in the case of treasuries. After the undertaken with the funds in an IRA are low risk in
initial issuance, investors can purchase from nature, guaranteeing a modest but consistent pattern of
other investors in the secondary market. growth.
The secondary market for a variety of assets can Many investors check stock prices and are confused because they
vary from loans to stocks, from fragmented to actually see three prices... the bid, the ask, and the price. All three
are very important indicators of the actual stock price, but don't
centralized, and from illiquid to very liquid. The feel stupid if you don't understand how to differentiate them.
major stock exchanges are the most visible The Spread and Market Makers
example of liquid secondary markets - in this The spread is the difference between the bid price and the ask
case, for stocks of publicly traded companies. price. The reason for this is simple. For a stock to be traded, there
Exchanges such as the New York Stock has to be a "market" for it. This means that if you want to sell,
there has to be someone willing buy from you; and if you want to
Exchange, Nasdaq and the American Stock buy, there has to be someone to sell to you. The people who
Exchange provide a centralized, liquid secondary "make the market" for your stock are called market makers. These
market for the investors who own stocks that are people (companies) that hold inventory of the underlying stock
trade on those exchanges. Most bonds and and regulate its buying and selling.
structured products trade “over the counter,” or Since the market makers are people employed by companies, they
have to make money. If they didn't make money, they couldn't be
by phoning the bond desk of one’s broker- in business, and there wouldn't be a market for people to buy and
dealer. Loans sometimes trade online using a sell stocks. The spread, the difference between the bid and ask,
Loan Exchange. generates profit for the market making companies.
Third market in finance, refers to the trading of For example, take Stock XYXY with a price of 10, bid 10, ask 10.50.
exchange-listed securities in the over-the- The spread for stock XYXY is (10.50 - 10 = .50) The market maker
keeps the $0.50 per share traded. Assume that stock XYXY traded
counter (OTC) market. These trades allow 1,000 shares yesterday, and the average spread was $0.50. That
institutional investors to trade blocks of gives the market makers a profit of 1,000 shares * $0.50 = $500.
securities directly, rather than through an The Bid
exchange, providing liquidity and anonymity to The bid is the price that you can sell your stock for. The term "bid"
buyers[1] comes from the fact that market makers are making a bid on the
stock you own. Basically, it's the price that they're willing to give
Third market trading was pioneered in the 1960s for your stock.
by firms such as Jefferies & Company although To simplify, think of an auction. The auctioneer is selling a Monet
today there are a number of brokerage firms painting (your stock), and the people in the audience (the market
focused on third market trading, and more makers) are bidding the price they're willing to pay.
recently dark pools of liquidity.[2] The Ask
The ask is the price that you can buy a stock for. It's basically the
Fourth market trading is direct institution-to-institution
amount that the market makers are "asking" you to give for the
trading without using the service of broker-dealers. It is stock. A good example is when you're looking for a new car to buy
impossible to estimate the volume of fourth market (the stock). You call the owner (the market makers) from the
activity because trades are not subject to reporting classified ad, and the first thing you say is "how much are you
requirements. Studies have suggested that several 'asking' for the car?"
million shares are traded per day. The Price
Cash accounts are brokerage accounts that require When looking at a stock quote the price is the dollar amount where
the stock was last bought or sold. So if the last trade was a sell
the client to render full payment for a transaction by the
order, the price was actually the bid price. If the last trade was a
agreed upon settlement date. The nature of a cash buy order, the price quoted is actually the ask price.
account means that the customer is not granted the Let's take a few examples.
privilege of buying on margin, or utilizing borrowed Stock ABC: Price 15 3/4, Bid 15 3/4, Ask 16
money secured through the broker in order to purchase
7. If you want to buy stock ABC, you'll have to pay the ask of 16. If you Earnings Surprise Definition
want to sell stock ABC, you must accept the bid of 15 3/4. The
An earnings surprise occurs when a company's
spread is $0.25.
Stock XYZ: Price 77 1/2, Bid 77 3/8, Ask 77 9/16 quarterly or annual report is above or below analysts'
earnings estimates. There is no set number which
If you want to sell stock XYZ you must accept a bid price of 77 3/8,
and if you want to buy you have to be willing to pay an ask of 77constitutes a earnings surprise, other than it is not
9/16. The spread is $0.183. within the expected consensus estimate. Many times
this surprise will lead to a sharp reaction in the stock.
Definition of Treasury Stock This reaction in the stock is also dependent upon how
Treasury Stock is shares of a corporation's capital stock that closely the stock is followed by analysts and the public
have already been issued and are now being re-purchased by at large. Like anything else in business, the number of
the same issuing corporation. active participants will lead to more volume and
potentially larger price swings.
These treasury shares may be held onto by the company Growth industry
permanently or may be re-issued at a later time to the
public. Shares of capital stock will not receive dividends, will Definition
not have the power to vote, and cannot share in the An industry which is growing earnings and/or revenue faster
distribution of assets upon dissolution of the company. than the overall market. Growth industries usually contain a
large number of growth stocks. Investments in such industries
It is also important to note that shares of a company's stock are usually suitable for investors who are willing to accept
larger risk in exchange for the possibility of larger returns.
that are held in treasury are not regarded as shares
‘’A sector of the economy experiencing a higher-than-
outstanding and therefore will not be used in the calculation
of earnings per share (EPS) average growth rate’’
Investopedia explains Growth Industry
For example, assume that a company currently has in-the-
If companies across an industry exhibit solid earnings and revenue
money options that cover 10,000 shares with an exercise figures, that industry may be showing signs that it is in its growth
price of $50. If the current market price is $100, the options stage.
are in-the-money and, based on the treasury method, need
to be added to the diluted EPS denominator. The proceeds Growth industries tend to be composed of relatively volatile and
the company will receive will be $500,000 ($50 x risky stocks. Often investors must be willing to accept increased
10,000), which allows them to repurchase 5,000 shares on risk in order to take part in the potentially large gains offered by
the market ($500,000/$100). stocks within a particular growth industry.
Therefore, the net of new shares is 5,000 (10,000 option Cyclical vs. Defensive
Industries that greatly differ from each other in terms of business activity
shares - 5,000 repurchased shares). can react similarly to changes in the economy. For example, cyclical stocks,
Ask Price like retail and travel, are sensitive to the economic cycle because in tight
Definition: The ask price is the lowest price you can pay for the economic periods, consumers are less likely to spend money on non-
stock. This is because it's the lowest price any seller is offering their essential items.
shares of stock for. Although the ask price might be $14, you might On the other hand, defensive stocks represent necessary items, like food,
pay slightly higher if you put in a large order. gas and medicine, and tend to change very little with the economic cycle
because consumers are likely to continue buying them even in tough
Some companies are very illiquid and have large spreads between
economic times.
the bid and ask prices. For example, a stock might be quoted at
Investing in both cyclical and defensive stocks can potentially help hedge
$13.50 but the ask price might actually be $14.00. If you place an against the risk you face by selecting only industries that react similarly to
order, you'll pay $14.00. That means you'll lose 3.5% of your changing market conditions
investment immediately BULLS AND BEARS IN THE MARKET
A Bull Market
Sustainable growth is the rate of growth that is most realistic
This is when the market showing is confidence. Indicators
estimate of the growth in a company’s earnings, assuming that the
company does not alter its capital structure. The most common
of confidence are prices going up, market indices like the
method of estimation is to estimate sustainable growth as the stock exchange go up too. Number of shares traded is also
product of the return on equity and earnings retention: high and even the number of companies entering the
Sustainable growth = return on equity retention rate stock market show that the market is confident.
The return on equity is the return per dollar of owners’ equity; the
return is calculated as the ratio of net income to book value of These are bullish characteristics. If there is a run of bullish
equity. The retention rate is the percentage of earnings retained days then you may hear the market is a bull market.
by the company – that is, not paid out in the form of dividends. In
Technically though a bull market is a rise in value of the
other words, the retention rate is the complement of the dividend
market of at least 20%. The huge rise of the Dow and stock
payout ratio (DPO).
exchange during the tech boom is a good example of a bull
8. market. For example, if you want to buy the stock of a "hot" IPO
that was initially offered at $9, but don't want to end up
A Bear Market paying more than $20 for the stock, you can place a
A bear market is the opposite of a bull. If the markets fall by limit order to buy the stock at any price up to $20. By
more than 20% then we have entered a bear market. A bear
entering a limit order rather than a market order, you
market is a market showing a lack of confidence. Prices
will not be caught buying the stock at $90 and then
hover at the same price then go down, indices fall too and
volumes are stagnant. In a bear market people are waiting suffering immediate losses if the stock drops later in the
for the bulls to start driving the prices up again. However, a day or the weeks ahead.
bear is a very tentative bull or a bull that is asleep. Convertible bond
Investopedia explains Risk-Free Rate Of Return Definition
In theory, the risk-free rate is the minimum return an investor A corporate bond, usually a junior debenture, that can be
expects for any investment because he or she will not accept exchanged, at the option of the holder, for a specific number of
additional risk unless the potential rate of return is greater than shares of the company's preferred stock or common stock.
the risk-free rate. Convertibility affects the performance of the bond in certain
ways. First and foremost, convertible bonds tend to have lower
In practice, however, the risk-free rate does not exist because interest rates than non-convertibles because they also accrue
even the safest investments carry a very small amount of risk. value as the price of the underlying stock rises. In this way,
Thus, the interest rate on a three-month Treasury bill is often convertible bonds offer some of the benefits of both stocks and
used as the risk-free rate.
bonds. Convertibles earn interest even when the stock is
trading down or sideways, but when the stock prices rise, the
Market Order value of the convertible increases. Therefore, convertibles can
A market order is an order to buy or sell a stock at the offer protection against a decline in stock price. Because they
current market price. Unless you specify otherwise, are sold at a premium over the price of the stock, convertibles
your broker will enter your order as a market order. should be expected to earn that premium back in the first three
or four years after purchase. In some cases, convertibles may
The advantage of a market order is you are almost
be callable, at which point the yield will cease.
always guaranteed your order will be executed (as long
as there are willing buyers and sellers). Depending on Commercial paper is the most prevalent form of
your firm’s commission structure, a market order may security in the money market, issued at a discount, with
also be less expensive than a limit order. a yield slightly higher than Treasury bills. The main
A market order is an order to buy or sell a stock at the issuers of commercial paper are finance companies and
current market price. A broker enters an order as a banks, but also include corporations with strong credit,
market order when requested to do so by his or her client. and even foreign corporations and sovereign issuers.
When a market order is placed, it is almost guaranteed The main buyers of commercial paper are mutual funds,
that the order will be executed. Ultimately, however, this banks, insurance companies, and pension funds.
depends on whether or not there is a willing buyer or Because commercial paper is usually sold in round lots
seller. of $100,000, very few retail investors buy paper.
A market order is usually less expensive than a limit order.
A limit order is an order to buy a security at a price no In law, a debenture is a document that either creates
greater than what has been specified by the owner. This a debt or acknowledges it. In corporate finance, the
gives the customer control over the price of the trade. A term is used for a medium- to long-term debt
buy limit order can only be executed by the broker. It also instrument used by large companies to borrow money.
has to meet or fall short of the limit price. In some countries the term is used interchangeably with
Limit Orders bond, loan stock or note.
To avoid buying or selling a stock at a price higher or Debentures are generally freely transferable by the
lower than you wanted, you need to place a limit order debenture holder. Debenture holders have no rights to
rather than a market order. A limit order is an order to vote in the company's general meetings of
buy or sell a security at a specific price. A buy limit shareholders, but they may have separate meetings or
order can only be executed at the limit price or lower, votes e.g. on changes to the rights attached to the
and a sell limit order can only be executed at the limit debentures. The interest paid to them is a charge
price or higher. When you place a market order, you against profit in the company's financial statements.
can't control the price at which your order will be filled. Zero growth
9. Definition by paying the call price, which is greater than the
Zero growth is a concept that all economic activities should aim at face value of the bond, to the bondholder. Often,
the equilibrium state rather than continuing growth which
ultimately leads to overshoot and the following collapse of the
callable bonds cannot be called until 5 or 10 years
system. after they were issued. When this is the case, the
bonds are said to be call protected. The date when
The main question is: can continuous growth in the context of the bonds can be called is refered to as the call date.
finite resources lead to prosperity? It seems contradictory, yet in The yield to call is the rate of return that an investor
most people's minds growth implies prosperity. It's so axiomatic
that no proof is required or sought. But is this belief, as universally
would earn if he bought a callable bond at its current
held as was once the notion that the earth is flat, be a truism, market price and held it until the call date given that
derived from faulty, simplistic observation, as wrong as was that the bond was called on the call date. It represents
earlier mistaken assumption? the discount rate which equates the discounted
value of a bond's future cash flows to its current
As the Zero Growth Initiative puts it: "In boasting of our prosperity,
our economic growth, are we like lemmings boasting of how many
market price given that the bond is called on the call
miles they have advanced in a day. Are we as blind to our ultimate date. This is illustrated by the following equation:
fate as those lemmings scurrying merrily to the awaiting sea? The
warnings are as obvious as the view out the window in any of our
great cities on a sultry summer day and as veiled as a chemical
reaction happening in an ionized stratum far above our growth-
distracted heads. "
A constant growth stock is a stock whose dividends
are expected to grow at a constant rate in the
foreseeable future. This condition fits many established
firms, which tend to grow over the long run at the same
Yield to Call Example
rate as the economy, fairly well. The value of a constant
growth stock can be determined using the following Find the yield to call on a semiannual coupon bond
equation: with a face value of $1000, a 10% coupon rate, 15
years remaining until maturity given that the bond
price is $1175 and it can be called 5 years from now
Constant Growth Stock Valuation Example at a call price of $1100.
Solution:
Find the stock price given that the current dividend
is $2 per share, dividends are expected to grow at a
rate of 6% in the forseeable future, and the required
return is 12%.
What Does Yield To Call Mean?
The yield of a bond or note if you were to buy and hold the security
until the call date. This yield is valid only if the security is called
Yield To Maturity - YTM
prior to maturity. The calculation of yield to call is based on the
coupon rate, the length of time to the call date and the market What Does Yield To Maturity - YTM Mean?
price. The rate of return anticipated on a bond if it is held until the
maturity date. YTM is considered a long-term bond yield expressed
Investopedia explains Yield To Call as an annual rate. The calculation of YTM takes into account the
Generally speaking, bonds are callable over several years and are current market price, par value, coupon interest rate and time to
normally called at a slight premium. maturity. It is also assumed that all coupons are reinvested at the
same rate. Sometimes this is simply referred to as "yield" for short.
Yield to Call
Many bonds, especially those issued by Investopedia explains Yield To Maturity - YTM
An approximate YTM can be found by using a bond yield table.
corporations, are callable. This means that the issuer However, because calculating a bond's YTM is complex and
of the bond can redeem the bond prior to maturity
10. involves trial and error, it is usually done by using a programmable but if it does it could mean that the company is undervalued and
business calculator. might be an attractive buy.
The Yield to maturity (YTM) or redemption yield of a bond What Does Book Value Per Common Share Mean?
or other fixed-interest security, such as gilts, is the internal A measure used by owners of common shares in a firm to
determine the level of safety associated with each individual share
rate of return (IRR, overall interest rate) earned by an
after all debts are paid accordingly.
investor who buys the bond today at the market price,
assuming that the bond will be held until maturity, and that Formula:
all coupon and principal payments will be made on schedule.
Yield to maturity is actually an estimation of future return, as
the rate at which coupon payments can be reinvested when
received is unknown.[1] It enables investors to compare the Investopedia explains Book Value Per Common Share
merits of different financial instruments. The YTM is often Should the company decide to dissolve, the book value per
given in terms of Annual Percentage Rate (A.P.R.), but more common indicates the dollar value remaining for common
usually market convention is followed: in a number of major shareholders after all assets are liquidated and all debtors are paid.
markets the convention is to quote yields semi-annually (see
compound interest: thus, for example, an annual effective In simple terms it would be the amount of money that a holder of a
yield of 10.25% would be quoted as 5.00%, because 1.05 x common share would get if a company were to liquidate.
1.05 = 1.1025). Book value per share
The ratio of stockholder equity to the average number of common
shares. Book value per share should not be thought of as an
DEFINITION indicator of economic worth, since it reflects accounting valuation
Yield to maturity is the most commonly used measure (and not necessarily market valuation).
of value of a bond. This yield includes the compounding Book value per share
of interest and assumes that the bond is held until Common stockholders' equity determined on a per-share basis.
maturity. Book value per share is calculated by subtracting liabilities and the
par value of any outstanding preferred stock from assets and
Book Value Per Share - BV dividing the remainder by the number of outstanding shares of
stock. Also called book, book value. See also market to book.
Stockholders Equity - Preferred Stock Moving Averages
=
Average Outstanding Shares What is a moving average?
Somewhat similar to the earnings per share, but it relates the Moving averages simply measure the average price or
stockholder's equity to the number of shares outstanding, giving
exchange rate of a currency pair over a specific time frame.
the shares a raw value.
For example, if we take the closing prices of the last 10 days,
Things to remember
add them together and divide the result by 10, we have
Comparing the market value to the book value can indicate whether or not the stock
in overvalued or undervalued. created a 10-day simple moving average (SMA).
During bull markets the stock price is more likely to trade significantly higher than
book value, and in a bear market the two value's may be close to equal. Over-The-Counter Market
[Click on the image(s) above to see the financial statements] What Does Over-The-Counter Market Mean?
A decentralized market of securities not listed on an exchange
where market participants trade over the telephone, facsimile or
For Cory's Tequila Co.
electronic network instead of a physical trading floor. There is no
$11,678 - $0 central exchange or meeting place for this market.
= $3.57
3271
Also referred to as the "OTC market".
Book Value Analysis:
For the most part the book value really doesn't tell us a whole lot. Investopedia explains Over-The-Counter Market
Cory's Tequila Co. is trading at over $100 and the BV is only $3.57? In the OTC market, trading occurs via a network of middlemen,
What is up with that? Well BV is considered to be the accounting called dealers, who carry inventories of securities to facilitate the
value of each share, drastically different than what the market is buy and sell orders of investors, rather than providing the order
valuing the stock at. And the truth is that market and book value matchmaking service seen in specialist exchanges such as the
have nothing in common. Market value is what the investment NYSE.
community's expectations are and book value is based on costs and
retained earnings. One situation where BV can be useful is if the
Over the counter (OTC) market
market value is trading below the book value, this rarely happens,
Definitions (2)
11. 1. UK: No OTC market on the pattern of the US exists but and markets are indications of future performance.
unlisted securities are traded on the Alternative Investment
Market of the London Stock Exchange (LSE). In a shopping mall, a fundamental analyst would go to each store,
2. US: OTC securities trading system in which brokers or dealers study the product that was being sold, and then decide whether to
(called market makers) negotiate over telephone or buy it or not. By contrast, a technical analyst would sit on a bench
computerized networks instead of through a stock exchange. in the mall and watch people go into the stores. Disregarding the
Trading rules for this market are established and enforced by intrinsic value of the products in the store, the technical analyst's
the National Association Of Securities Dealers. In dollar terms, it decision would be based on the patterns or activity of people going
into each store.
is the largest securities market in the US. Also called outside
market or third market. See also NASDAQ. Short sale
Bid Price and Ask Price Definition
The stock exchanges are the places where the actual setting of the Borrowing a security (or commodity futures contract) from a
stock prices happens. They are the places where bid and ask prices broker and selling it, with the understanding that it must later
cross their ways and the exchange serves as the intermediary be bought back (hopefully at a lower price) and returned to the
between the two. broker. Short selling (or "selling short") is a technique used by
So, as an educated investor you should be acquainted with the investors who try to profit from the falling price of a stock. For
meaning of bid and ask prices.
example, consider an investor who wants to sell short 100
Bid price is the price announced by the buyer at which s/he is
shares of a company, believing it is overpriced and will fall. The
willing to purchase a stock.
investor's broker will borrow the shares from someone who
Ask price is the price announced by the seller at which s/he is
willing to sell a stock.
owns them with the promise that the investor will return them
The major role of the exchange is to coordinate the bid and ask later. The investor immediately sells the borrowed shares at the
prices of buyers and sellers. This service, of course, is not for free. current market price. If the price of the shares drops, he/she
Bid and ask prices are never the same. In fact, the price announced "covers the short position" by buying back the shares, and
by the seller (the ask price) is always higher than the bid price. As a his/her broker returns them to the lender. The profit is the
result you are required to pay the ask price in case you have difference between the price at which the stock was sold and
decided to purchase a stock and pay a higher price. On the other the cost to buy it back, minus commissions and expenses for
hand, if you decide to sell a stock you will have to receive the bid borrowing the stock. But if the price of the shares increase, the
price, which is of a lower amount than the ask price. potential losses are unlimited. The company's shares may go up
Open-End Fund and up, but at some point the investor has to replace the 100
shares he/she sold. In that case, the losses can mount without
What Does Open-End Fund Mean? limit until the short position is covered. For this reason, short
A type of mutual fund that does not have restrictions on the selling is a very risky technique. For a while, SEC rules only
amount of shares the fund will issue. If demand is high enough, the allowed investors to sell short only on an uptick or a zero-plus
fund will continue to issue shares no matter how many investors tick, to prevent "pool operators" from driving down a stock
there are. Open-end funds also buy back shares when investors price through heavy short-selling, then buying the shares for a
wish to sell. large profit. This rule was eliminated in July 2007.
Investopedia explains Open-End Fund
Bid Ask Quote
The majority of mutual funds are open-end. By continuously selling A two-way price comprising a bid, or the price at which a
and buying back fund shares, these funds provide investors with a dealer is willing to buy, and an ask (or offer) at which a
very useful and convenient investing vehicle. dealer is willing to sell. The bid, by definition, is always below
the ask and is always the first quoted price. The difference
It should be noted that when a fund's investment manager(s) between the two quotes is known as the spread. The spread
determine that a fund's total assets have become too large to between the best bid and best offer is called the touch.
effectively execute its stated objective, the fund will be closed to
new investors and in extreme cases, be closed to new investment
by existing fund investors. Support
Technical Analysis A support level is a price level where the price tends to
find support as it is going down. This means the price is
What Does Technical Analysis Mean? more likely to "bounce" off this level rather than break
A method of evaluating securities by analyzing statistics generated through it. However, once the price has passed this
by market activity, such as past prices and volume. Technical
analysts do not attempt to measure a security's intrinsic value, but
level, by an amount exceeding some noise, it is likely to
instead use charts and other tools to identify patterns that can continue dropping until it finds another support level.
suggest future activity.
Investopedia explains Technical Analysis
Technical analysts believe that the historical performance of stocks
12. Resistance 270 days. The debt is usually issued at a discount, reflecting
prevailing market interest rates.
A resistance level is the opposite of a support level. It is Investopedia explains Commercial Paper
where the price tends to find resistance as it is going up. Commercial paper is not usually backed by any form of
This means the price is more likely to "bounce" off this collateral, so only firms with high-quality debt ratings will
level rather than break through it. However, once the easily find buyers without having to offer a substantial
discount (higher cost) for the debt issue.
price has passed this level, by an amount exceeding
some noise, it is likely that it will continue rising until it A major benefit of commercial paper is that it does not need
finds another resistance level. to be registered with the Securities and Exchange
Commission (SEC) as long as it matures before nine months
Bond Rating
(270 days), making it a very cost-effective means of financing.
What Does Bond Rating Mean?
The proceeds from this type of financing can only be used on
A grade given to bonds that indicates their credit quality.
current assets (inventories) and are not allowed to be used on
Private independent rating services such as Standard &
fixed assets, such as a new plant, without SEC involvement.
Poor's, Moody's and Fitch provide these evaluations of a
bond issuer's financial strength, or its the ability to pay a
bond's principal and interest in a timely fashion.
Investopedia explains Bond Rating
Bond ratings are expressed as letters ranging from 'AAA',
which is the highest grade, to 'C' ("junk"), which is the lowest
grade. Different rating services use the same letter grades,
but use various combinations of upper- and lower-case letters
to differentiate themselves.
To illustrate the bond ratings and their meaning, we'll use the
Standard & Poor's format:
AAA and AA: High credit-quality investment grade
AA and BBB: Medium credit-quality investment grade
BB, B, CCC, CC, C: Low credit-quality (non-investment
grade), or "junk bonds"
D: Bonds in default for non-payment of principal and/or
interest
Portfolio Management
What Does Portfolio Management Mean?
The art and science of making decisions about investment
mix and policy, matching investments to objectives, asset
allocation for individuals and institutions, and balancing risk
against. performance.
Portfolio management is all about strengths, weaknesses,
opportunities and threats in the choice of debt vs. equity,
domestic vs. international, growth vs. safety, and many other
tradeoffs encountered in the attempt to maximize return at a
given appetite for risk.
Investopedia explains Portfolio Management
In the case of mutual and exchange-traded funds (ETFs),
there are two forms of portfolio management: passive and
active. Passive management simply tracks a market index,
commonly referred to as indexing or index investing. Active
management involves a single manager, co-managers, or a
team of managers who attempt to beat the market return by
actively managing a fund's portfolio through investment
decisions based on research and decisions on individual
holdings. Closed-end funds are generally actively managed
Commercial Paper
What Does Commercial Paper Mean?
An unsecured, short-term debt instrument issued by a
corporation, typically for the financing of accounts
receivable, inventories and meeting short-term liabilities.
Maturities on commercial paper rarely range any longer than